On it grows, for now

Confounding the doomsayers in the media yet again, the Canadian economy grew at a 2.1 percent annualized rate in the second quarter of 2023. This was (a) faster than the previous quarter; (b) faster than the Bank of Canada's forecast and (c) the fastest pace of growth since the first quarter of 2023. 

GDP growth in the quarter mainly reflected two factors: higher government consumption spending -- no surprise there -- and a welcome surge in business fixed investment, led by spending on transportation equipment. Household spending, which had been very strong in the first quarter of the year, edged lower in Q2, with spending on durable goods falling while spending on food and services continued to increase. 

The fly in the ointment here continues to be per capita GDP, which fell once again in Q2, its fifth consecutive quarterly decline. Since the growth rates recorded in both Q1 and Q2 are not far from most estimates of the economy's potential growth rate, it seems beyond argument that the per capita weakness is the result of excessive immigration rates rather than any underlying structural issues in the economy.  The Federal government seems to be waking up to this reality, proclaiming its intention to curb immigration in the years ahead, but it remains to be seen whether this will help it at next year's election. 

Monthly GDP data were released alongside the quarterly data, and appear to show that the economy had little to no forward momentum at mid-year. After growing 0.1 percent in May, real GDP was unchanged in June, and StatsCan's preliminary data also suggests a flat result for July. This weak "handoff" suggests that growth for Q3 as a whole will be weaker than for Q2. 

There is nothing in today's data to change the Bank of Canada's policy course, with a further 25 basis point reduction likely to be announced on September 4. Market consensus is now calling for similar reductions at the Bank's two fixed announcement dates in October and December. The near-term outlook for slow growth and tame inflation makes that the likeliest outcome, with the easing cycle set to continue into 2025.  

Electric shock

Take a look at this document from the Office of the Parliamentary Budget Officer (PBO) in Ottawa. Over the few years the Federal government, enthusiastically supported by several Provinces, has been firehosing money at manufacturers of electric vehicles, in an effort to persuade them to locate in Canada. As the PBO figures it, a total of C$ 46.1 billion in investments has been announced since 2020 by thirteen manufacturers, including such cash-strapped minnows as GM, Ford, VW and Honda. Remarkably, the total government "investment" to support all of this amounts to almost C$ 52.5 billion.  That's right -- government support actually exceeds the total amount that will be invested in these projects. 

And today we find Prime Minister Justin Trudeau, ramping up the populist rhetoric as his government sinks in the opinion polls, announce that from October 1, Canada will impose a 100 percent tariff on electric vehicles imported from China, which has allegedly ''chosen to give themselves an unfair advantage in the global marketplace".  The stupidity (or is it hypocrisy) is breathtaking, even by Justin's standards. Has  anyone in government paused to consider that if you need massive tariffs even after paying for more than 100 percent of the investment in a particular industry, maybe that's not an industry you can ever be truly competitive in. 

It's true that Canada may not have had much of a choice in this matter. The United States has already imposed 100 percent tariffs on Chinese EVs, and has been leaning heavily on its trading partners to do the same. Locked into the free trade deal with the US and Mexico, and with a new Trump presidency possibly looming, saying no was never a real possibility. What's not clear, however, is that Canada's massive subsidies to the EV industry will pass muster with the incoming US administration, whichever party that may be. Protectionism is never far below the surface in the US, and Canada's subsidies here are egregious in scope. 

In fact, let's hazard a guess at where the first lawsuit may come from. Every Tesla currently sold in Canada comes from a factory in Shanghai and will be subject to the new tariffs come October.  Tesla has somehow contrived not to receive any of the Canadian government's recent largesse.  We await Elon Musk's reaction to today's announcement. 

Much more than a hint

The much-anticipated Fed rate cutting cycle will begin in September. Speaking this morning at the KC Fed's annual Jackson Hole symposium, Fed Chair Jerome Powell made that perfectly clear:

"The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks".

Powell began his remarks by reviewing how recent economic data meant that it was now appropriate for the Fed to worry less about inflation and instead pay more attention to the deterioration in the labour market. It's arguable that this was a decision the Fed could and should have reached before the July FOMC meeting, so it seems very likely that the large downward revision in monthly employment data revealed by the BLS earlier this week played a role in the Fed's timing. 

Be that as it may, the Fed remains confident that it is shifting gears at the right time:

"So far, rising unemployment has not been the result of elevated layoffs, as is typically the case in an economic downturn. Rather, the increase mainly reflects a substantial increase in the supply of workers and a slowdown from the previously frantic pace of hiring. Even so, the cooling in labor market conditions is unmistakable. Job gains remain solid but have slowed this year".

And: 

"With an appropriate dialing back of policy restraint, there is good reason to think that the economy will get back to 2 percent inflation while maintaining a strong labor market. The current level of our policy rate gives us ample room to respond to any risks we may face, including the risk of unwelcome further weakening in labor market conditions".

It is very unusual for a central banker to tip their hand like that, so there can be no doubt that the Fed will follow through with a rate cut at the September 18 FOMC meeting. It remains overwhelmingly likely that the first move will be a 25 basis point cut, rather than anything larger.  There is nothing in Powell's remarks to suggest that the Fed thinks it has fallen behind the curve.  However, the likelihood that each of the two FOMC meetings after September will produce further rate cuts has clearly increased in the wake of Powell's comments today. 

Canada CPI data seal the deal

Canada's CPI data for July, released by Statistics Canada this morning, make it all but certain that the Bank of Canada will implement a further 25 basis point cut in interest rates at its next fixed announcement date, on September 4.  Headline CPI rose 2.5 percent in July from a year ago, down from the 2.7 percent reported for June, marking the smallest annual increase since March 2021.  

The favourable year-on-year outcome owed a great deal to a helpful base effect, as the monthly increases -- 0.4 percent unadjusted, 0.3 percent seasonally adjusted -- were slightly less encouraging. StatsCan drew particular attention to prices for travel tours, which fell 2.8 percent in July, whereas in July 2023 they had risen very rapidly in response to the removal of COVID restrictions. That being said, all of the major sub-components of the headline index are now within the Bank's 1 - 3 percent target range, except for shelter costs, which stood 5.7 percent higher than a year ago as a result of increases in mortgage costs and rents. 

The main special aggregates are also within the target range, with all items except food rising 2.5 percent and all items except food and energy up 2.7 percent.  All three of the Bank's preferred measures of core inflation also moved lower in July, with their mean value falling to just under 2.5 percent.

Beyond the now inevitable September cut, the Bank of Canada's policy actions for the balance of 2024 and into 2025 will remain data-dependent. As long as monthly inflation data remain well-behaved, the Bank's decisions will increasingly be based on the performance of the real economy, and particularly the labour market. In the event that the economy really does tip over into the recession the media have been craving for the last two years and more, the Bank now has much more flexibility to do something about it. 

Hey Kamala and Donald -- here's a tip for ya!

If there's one thing you could probably get most Americans to agree on (and most Canadians too, but that's not relevant here), it's that tipping culture is completely out of hand. Pre-programmed tip amounts on payment devices in restaurants are going ever higher, with most now using 18 percent as a starting point; tip-shaming supposed cheapskates is rising, amid suggestions online that anything less than 28 percent is now entirely unacceptable; and the demand for tips is spreading into more and more workplaces, including some where actual contact between customer and employee is minimal. It's one malign consequence of the pandemic years that shows no sign of abating any time soon.

Now we have both major candidates for the Presidency saying they want to exempt tip income from taxation. Donald Trump suggested it first, but now Kamala Harris is touting the same idea.  And while it may play well on the campaign trail, from any public policy standpoint it's a truly terrible idea.

This article from CNN spells out many of the reasons why that's the case. Basically, the case not to do this comes down to the good old Law of Unintended Consequences.  One: eliminating taxation on tips directly reduces any incentive for employers to pay their staff a living wage. Two: in all likelihood it reduces the percentage that customers actually tip -- "hey, I've paid tax on this money that I'm tipping you, but you won't be paying tax on it, so it's only fair that I give you less, right?" Three: eliminating taxation on tips creates incentives for smart people to structure their compensation in order to take advantage. Ready to start tipping your investment broker? Just give it time. 

Alongside all of these potential downsides, there's the uncomfortable fact that most employees currently in receipt of tips don't earn enough to pay Federal taxes anyway, so there's very little point to all this. Any change in the taxation of tips would require the approval of Congress. The Presidential candidates may ride this dumbass idea right through election day, but it seems unlikely it will ever be implemented.  

Canada's July jobs data: nothing to like

The July employment data released this morning by Statistics Canada make grim reading. True, the unemployment rate was unchanged at 6.4 percent after edging higher for many month, but just about all of the details of the report make grim reading -- and even the unemployment rate may be understated, given the growth in the working age population during the month.  

The economy shed 2800 jobs in the month, with a gain of about 61,000 full time jobs more than offset by a decline of  about 64,000 in part time employment.  The private sector shed 42,000 jobs in the month, while public sector employment rose by 41,000. Over the past year, private sector employment has risen 0.6 percent, against a 4.8 percent rise in public sector jobs.

Some of the big picture statistics provide cause for concern. In line with recent trends, the working age population surged by 125,000 in the month, and yet the labour force supposedly fell by 11,000. Given "normal" participation rates, the labour force might have been expected to rise by about 50-60,000 in the month, which would have pushed the unemployment rate sharply higher. It remains to be seen whether these figures will be revised: recall that Canada's monthly employment figures are notoriously volatile. 

In further evidence of the deterioration in underlying labour market conditions, both the participation rate and the employment rate continued their slow but steady march lower. Aside from some depressed readings in 2020/21 (i.e. the COVID pandemic), the participation rate now stands at its lowest level since 1998. 

All of these numbers point unambiguously to a further rate cut by the Bank of Canada in September.  Given Canada's poor productivity performance, the 5.2 percent annual rise in hourly earnings reported for July (down from 5.4 percent in June) is still way too high for the Bank's comfort. However, it is becoming increasingly clear that the downside risks for the real economy are starting to outweigh the upside risks for inflation. 

Has the Fed fallen behind?

At his post-FOMC media scrum just two days ago, Fed Chair Jerome Powell repeatedly reminded his audience that the Fed's mandate requires it to focus on two goals: maximum employment and stable prices.  He described the Fed's current stance this way: "we weigh those two things equally under the law. When we were far away from our inflation mandate, we had to focus on that. Now we're back to a closer to even focus, so we'll be looking at labor market conditions and asking whether we're getting what we're seeing and as I said, we're prepared to respond if we see that it's not what we wanted to see, which was a gradual normalization of conditions". 

This morning the BLS reported that US employment gains slowed sharply in July, falling to 114,000,  compared to an average of about 170,000 in the preceding three months, pushing the unemployment rate up to 4.3 percent. This was the second-lowest monthly gain, behind only April of this year, since the depths of the COVID slowdown in December 2020. It is generally (and correctly) assumed that the Fed is given a sneak peak at any imminent data releases that may have a major impact on its decision making, so it's hard to believe that it did not have at least a general idea of how today's numbers were going to look. Has it, as Senator Elizabeth Warren stated this morning, "made a serious mistake in not cutting interest rates" this week?

All central banks hate to see their rate decisions turn into political footballs. Chair Powell tried to make it clear at his media conference that the timing of any Fed rate moves this year would not be influenced by anything relating to the Presidential election. (Recall that after the September meeting, where a rate cut is now seen as fully baked in, the next FOMC session begins on November 6, the day after election day).  Perhaps so, but the loud criticism from Senator Warren makes it perfectly clear who stands to lose the most if the Fed gets it wrong. If the much-touted successes of "Bidenomics" are starting to unwind, the impact on the Harris election campaign could be severe indeed. 

A rate cut this past Wednesday would have been something of a surprise, but markets would have fully understood it as soon as today's non-farm payrolls data appeared.  Now, the Fed has placed itself in a truly invidious, "damned if you do, damned if you don't" position. Powell will surely ignore Senator Warren's demand that he "cancel his summer vacation and cut rates now — not wait 6 weeks.” But whatever choice he and the FOMC make from now on (a 25 bp cut in September? -- too little too late!; a 50 bp cut? -- panic stations!) -- will be fodder for the election campaign, a very uncomfortable situation for the Fed. 

With the benefit of just two days' hindsight, it's hard to see this week's rate decision as anything other than an unforced error.